IRS's Small Business/Self-Employed (SB/SE) Division has issued an internal memorandum which says that the trust fund recovery penalty (TFRP) may be imposed against third-party payroll service providers as well as the employer.
Trust fund recovery penalty. Code Sec. 6672 imposes the TFRP on any person who: (1) is responsible for collecting, accounting for, and paying over payroll taxes; and (2) willfully fails to perform this responsibility. The amount of the penalty is equal to the amount of the tax that was not collected and paid. The penalty is imposed on a “responsible person.” A responsible person may be anyone in a business entity who has the duty to collect, account for, or pay over the tax.
Common law employers. The new IRS memorandum applies to “common law employers.” A common law employer is any person who has the status of employer under the usual common law rules applicable in determining the employer-employee relationship.
Factors considered by courts in determining whether an employer-employee relationship exists include:
(1) the degree of control exercised by the principal;
(2) which party invests in the work facilities used by the worker;
(3) the opportunity of the individual for profit or loss;
(4) whether the principal can discharge the individual;
(5) whether the work is part of the principal's regular business;
(6) the permanency of the relationship;
(7) the relationship the parties believed they were creating; and
(8) the provision of employee benefits.
Third-party arrangements. Common law employers may designate a third party who is not the common law employer or a statutory employer under Code Sec. 3401(d)(1) to take over some or all of the employer's federal employment tax withholding, reporting, and payment responsibilities and obligations. A third party that could be subject to a TFRP includes a payroll service provider, a professional employer organization, or a employee leasing company that is not the common law or statutory employer. The TFRP may be assessed against the payroll service provider, professional employer organization, or responsible parties within those entities.
New guidance. A third-party payer is considered a responsible person under Code Sec. 6672 if the person had significant control over the payment of its client's employment taxes. A third-party payer is considered to have willfully failed to perform the payroll tax responsibility if the failure to perform the responsibility was intentional, deliberate, voluntary, reckless, or knowing, as opposed to accidental. No evil intent or bad motive is required.
The memo identified a number of factors considered by IRS in determining willfulness in situations involving third-party payers, including whether the client had knowledge of a pattern of noncompliance by the third-party payer at the time the delinquencies were accruing, whether the third-party payer fraudulently concealed the noncompliance from the client, and whether the client had received prior IRS notices indicating problems with its employment tax returns.
Use of a third-party payer does not relieve a common law employer from its responsibilities of ensuring that its tax obligations are met. A common law employer that uses a third party to prepare its employment taxes can still be subject to the TFRP if it satisfies the responsible person and willfulness requirements of Code Sec. 6672(a). The employees can also be subject to the TFRP.
References: For who is a “responsible person,” see FTC 2d/FIN ¶V-1704; United States Tax Reporter ¶66,724; TaxDesk ¶864,005; TG ¶71654. For determining the existence of an employment relationship, see FTC 2d/FIN ¶H-4250; United States Tax Reporter ¶34,014.37; TaxDesk ¶535,001; TG ¶9160.